As a 30-something year old male with an interest in finance, you can be sure that the vast majority of advertising targeted at me via social media is similar to the above – how to get rich trading foreign exchange or oil futures or gold in my lunch break, with the occasional Tom Waterhouse ad for good measure!
At least Tom Waterhouse is honest: there’s no hiding that he’s advertising a gamble on horse racing or sporting events.
Funnily enough, all of the other ads that sell the allure of quick returns don’t explain much of the detail. Important detail like the fact that when making these trades they can involve leverage of up to 400:1.
It’s difficult to comprehend sometimes what 400:1 leverage means, so I’m going to use an example to demonstrate this using a recent piece of history.
For the last few years, the Swiss National Bank has operated what’s called a currency peg to the Euro. This means that they guaranteed that 1 Euro would be worth 1.20 Swiss Francs. The Swiss National Bank guaranteed this exchange rate from 2012, until a week ago when they decided to no longer support this rate. The Swiss Franc when traded against the Euro (a common foreign exchange trade) dropped by 20% in a matter of days.
So what does a 20% drop in the value of the underlying asset look like when you’re trading foreign exchange with leverage?
At 20:1 leverage, you need to put down a 5% deposit on the trade you place. So if you place a trade on $100,000 then the amount you need to deposit into your trading account is $5,000.
If that $100,000 trade drops by 20%, it’s now worth $80,000. This means you’ve lost the $5,000 you put into your trading account, and you owe your broker another $15,000. Ouch.
(This scenario is what one foreign exchange broker’s website referred to as befitting a “low risk persona.” Low risk!)
At 400:1 leverage, the deposit required is a mere 0.25%. So Joe the punter, who got into this whole foreign exchange trading business after seeing a Facebook ad only needs to deposit $250 into his trading account. Joe has probably punted more than this on the football some weekends, and I’m going to guess that if he was introduced to foreign exchange trading by social media advertising, he probably didn’t read the detailed disclosure documents very carefully.
I’d speculate that Joe thinks that if all this goes wrong, just like when he places a bet with his mate Tom Waterhouse, his worst case scenario is that he loses the $250 he put down.
Joe’s broker has a very different opinion. If Joe is on the wrong end of that 20% shift in Swiss Francs, his broker is going to first of all take the $250 put down as a margin, but the broker is then going to kindly remind Joe that his exposure was to a $100,000 trade and as such he still owes the remainder of the $20,000 loss – a cool $19,750.
So I am going to continue to ignore the ads offering me foreign exchange trading riches in my lunch break, and would suggest others do as well. If nothing else from this example: take away these 3 concrete rules:
- Don’t select your investments based on social media advertising
- If making money investing looks easy, you’re not looking at the full picture
- If you’re unsure about what an investment is, talk to somebody with experience
…stay safe with your money!